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| Bank Of Ghana! “Push” The Banks To Lower Interest Rates |
8/6/2010 |
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It is time our nation’s central bank takes the necessary steps and come out with practical initiatives to make its prime rate effective and monetary policy beneficial to Ghanaians.
The prime rate is the rate at which the Bank of Ghana (BoG) may lend to the regulated commercials banks overnight, often to meet their reserve requirements. The Banks also use the prime rate to communicate its stance on inflation. It is generally believed that, and indeed as it pertains in most liberalized financial markets, the central bank can influence market lending rates through the prime rate. Thus, as the BoG reduces its prime rate, commercial banks must also accordingly reduce their lending rates. This has however not been, quite clearly, the case in Ghana
The former governor of the BoG, Paul Acquah, has said on many occasions, while in office, that he believes Ghanaian banks lend at the upper end of the interest rate spread despite the lowering of the prime rate but didn’t believe, agreeably, in stampeding the banks. Both ex President Kuffour and President Mills have on many occasions lashed out on the banks for not reducing interest rates. The finance minister, Kwabena Duffour and the governor Amissah-Authur, too, have since the reduction of the prime to 13.5% been morally persuading commercials to reduce lending rates but we are still yet to see any appreciable drop in lending rates.
The anomalies in the interest rate transmission in Ghana are that, on the one hand, the downward movements of market lending are very sticky. The prime rate has dropped from 18.5% to 13.5% within the last two years but average lending rate still hovers around 31% and still in the range of 24 – 35.0%. On the other hand, the commercial banks are quick to cut interests on deposits with them as the prime rate is cut. There were fixed deposits paying about 28% when the prime rate was 18.5% but those rates have now dropped to about 12% as the prime rate is cut to 13.5%. These anomalies, in my opinion, have rather made monetary policy rate cuts a punishment to Ghanaian households and businesses as they lose on interest earnings and still face high lending rates from banks.
The commercial banks have been largely silent on the issue. From their perspectives, however, it is not automatic that they reduce lending rates as and when the prime rate is reduced. They borrow from depositors at a cost and take into consideration the high administrative cost they face (bank staffs are one of the most well paid) and risk premium, when setting their lending rates. While, the rates on deposits in saving accounts and inter bank rates may fall directly as the result of a reduction in the prime rate, rates on some of the other instruments use to finance credit may not necessarily drop. The banks also face default risk--- which is rising in Ghana at the moment. According to the BoG’s own data, the ratio of non performing loans to gross loans is currently up to 18.7% from 7.7 % in December 2008.
Lenders face inflation risks too—the risk of loss in the value of a loan in future due to inflation. Although we are experiencing some form of disinflation at the moment, the inflation risk premium depends more on the lenders’ own permanent view on inflation and future inflationary expectations rather than the central banks stance on inflation. Let’s face it, people are used to high inflation in Ghana and expect high premium for bearing inflation risk. May be, the BoG needs to do more to convince people that inflation would continue to go down and would remain low for a very long time.
More importantly, the banks also face the “term risk of interest rates”. This comes from the fact that banks borrow from depositors on short term, sometimes even on daily and hourly basis, and lend to their borrowers on long term basis. So even if the short term prime rate and deposit rates fall, lenders cannot automatically lower lending rates as the prime rate and interest rates on sources of credit could easily rise during the terms of the loans. I hope the policymakers at the Bank of Ghana will recognize and share the view that the “term risk of interest rate” is one of the main reasons why the banks are reluctant to lower lending rates and unwilling to create long term credits.
The bottom line is that the conduct of monetary policy in Ghana is constrained in many ways. One, quite often many commercial banks have been observed to even be keeping more than the BoG’s reserve requirements, they claim, due to lack of viable lending opportunities, in which case the prime rate is meaningless to them.
Second, large amount of cash are held outside the banking system due to excessive cash transaction and to a large extend not influenced by the prime rate or monetary policy in general. The E-Zwich project could have reduced this problem, however, the implementation, in my view, is flawed and the outcome so far is very poor.
Another constraint to monetary policy is the huge public sector borrowing which is insensitive to interest rates. On the one hand, investment credit is very sensitive to interest rates. Businesses and investors would not borrow and/or the banks would not lend unless they believe the expected EBIT (earning before interest and tax) on an investment opportunity exceeds interest rates. Personal loans may be less sensitive, but genuine households also care a lot about the level of interest rates when borrowing to acquire durable assets or tide up their finances. On the other hand, the Treasury, the largest borrower would borrow any amount regardless of interest rates. The Treasury bill rates may have dropped to about 13.60% now, but it has been quite high most of the time. So long as the government is willing to borrow hugely and the treasury bill rate is reasonable, the banks would have the tendency to channel funds into the risk free bills rather than lending, unless borrowers are willing to pay high interest rates.
Taking practical steps to remove some of the constraints analyzed above would be the best way to bring market lending rates down in the long run. In the meantime though, reducing the “interest rate term risk” by promoting variable / floating interest rate as opposed to the predominantly permanent fixed regimes, we have now, will be an effective way to make the banks immediately lower lending rates and create long term credits. With a fixed interest rate, the interest payment on a loan remains fixed during the life of the loan and with a variable rate the interest payment changes as trackers such the prime rate changes.
Encouraging the use of variable interest rates will make market lending rates more responsive to changes in the prime rate. With the variable interest rate type the interest payment on loan by borrowers—both new and existing ones---can fall almost immediately as the prime rate falls. Of course a rise in the prime rate will also lead to a rise in the lending rate, seemingly not good news for borrowers particularly for existing borrowers, who will see rise in interest payment on loans. However this possible rise could often be more than compensated for by lower variable interest rates.
In variable interest rate regimes, banks would be encouraged to create long term products such as 15 years loan with variable but fixed for 1 or 2 years interest rates. Thus if one accesses such a facility, the interest rate could be fixed for 2 years to allow for some certainty but would be adjusted every 2 years depending on the prime rate.
To ensure interest rate stability and also limit extraordinarily excessive increases in the interest rate which can be destructive for existing borrowers, the central bank could act as the ‘insurer of bankers’ and provide a facility to cap, the maximum increases in the rates. Thus given a variable rate of r, borrowers should only face up to (r+x). If rates have to rise more than (x) the central bank should compensate the lending banks. This could be financed by fees the commercial banks will pay for the facility. For new borrowers the higher prime rate and hence higher variable lending rates only means the central bank’s stance on inflation and the intention to limit lending. Encouraging variable rates will help reduce market lending rates, making the prime rate more effective, and increase availability of long term credits.
Promoting the use of prime rate to index contracts, cost, business debt and plan expenditure can also be one of the ways to make the prime rate more effective. For monetary policy to be effective in leading financial development ( movements in market interest rates, credit creation, and inflation) and economic growth firms and households must have confidence in the prime rate and to some large extend make use of it in financial transactions. Examples of such uses of the prime rate include its use as a tracker in determining variable interest rates; the rise in cost of ongoing and planned projects; and how future prices such as rent or some charges should rise. Such uses of the prime rate seem to be lacking at the moment and must be encouraged and promoted by the Bank of Ghana. If the government for instance starts using the prime rate as tracker in its forward financial arrangement, businesses and households would soon follow.
Harrison Adjimah (A Lecturer & Economist, Ho Polytechnic)
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